Iron ore feels the pressure from China crackdowns

Lacklustre performance in China’s property sector and a tightening liquidity environment are placing downward pressure on iron ore prices.
Nanjing Night Net

Steel production growth in China, the world’s largest buyer of iron ore, has eased in 2014, causing a significant slump in the price of iron ore, which has fallen 19.3 per cent since the beginning of the year to $US108.30 per tonne on Tuesday night.

Any up-tick in steel production growth and therefore iron ore prices, is highly contingent on China’s residential property sector, which accounts for 24 per cent of consumption.

“Fixed asset investment in China still looks like it will be quite lacklustre, the leading indicator of steel production growth – looks like it will be quite weak, the housing market looks like it will continue to be quite weak from a building perspective,” Deltec International chief investment officer Atul Lele told Fairfax Media.

New property construction in China fell by 25.2 per cent in the first quarter of this year, while the value of homes sold fell 7.7 per cent, according to the National Bureau of Statistics.

Iron ore prices have continued to fall in April, despite the People’s Bank of China, last week, announcing it would cut the amount of deposits that rural banks must hold in reserves. Rural commercial banks will have the reserve requirement ratio (RRR) cut by 2 per cent. The move hopes to give greater access to funds in an attempt to stimulate lending and growth.

Earlier in April, China also introduced stimulus in the form of railway construction, with 150 billion yuan ($25.8 billion) in bonds to be sold to fund the project.

The impact of the railway project on iron ore prices has been limited, despite the bulk metal being key in construction. The Iron ore price has fallen 7.3 per cent in April.

“It’s particularly worrying that you’re seeing iron ore and commodity price volatility and outright commodity price declines at the time when the Chinese government has introduced stimulus over the last few weeks. If they’re introducing stimulus and activity is still falling, that’s a problem,” Mr Lele said.

Financial stability in China is at risk, Mr Lele said while releasing Deltec’s quarterly outlook report, due to the level of leverage across the entire economy, especially with commodities such as iron ore being used as collateral.

China’s banking regulator is expected to crack down on these financing deals by increasing the required deposit amount on credit deals with iron ore used as collateral.

From a financial stability point of view, getting rid of risky financing arrangements that are linked to an asset as volatile as iron ore is a positive step for China, but for commodity prices it is negative.

“You’re removing a layer of demand, which is negative for commodities. [At present] you’ve got underlying demand which is going into residential property and fixed asset investment for iron ore, but then you’ve got a level of demand that’s coming through for financing arrangements,” Mr Lele said.

Iron ore’s fall in April has brought it down to levels where it is fairly valued, Mr Lele said, however longer term, a slowing in steel production growth momentum provides considerable downside risk.

“We see iron ore heading down, save any stimulus aimed at fixed asset investment in China, which we don’t think is likely in a significant way,” Mr Lele said.

“The combination of weakness in residential property markets in China, steel production growth remaining weak, steel inventory levels remaining high, iron ore inventories remaining high and increased supply coming on board, that all points to downside.”

This story Administrator ready to work first appeared on Nanjing Night Net.

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